Steve Hamilton is a Tampa native and a graduate of the University of South Florida and the University of Missouri. He now lives in northern Kentucky. A career CPA, Steve has extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.

Thursday, November 5, 2015

So What If You Do Not File A Gift Tax Return?

Let’s talk a
little federal estate and gift tax.

It is
unlikely that you or I will ever be subject to the federal estate tax, as the
filing exemption is $5,430,000 for decedents passing away in 2015. If I was
approaching that level of net worth, I would reduce my practice to part-time
and begin spending my kid’s inheritance.

Let’s say
that you and I are very successful and will be subject to the federal estate
tax. What should we know about it?

The first
thing is the $5,430,000 exemption we mentioned. If you are married, your spouse
receives the same exemption amount, resulting in almost $11 million that you
and your spouse can accumulate before there is any federal tax.

The second
thing is that the federal estate tax is unified with the federal gift tax. That
means that – at death - you have to add all your reportable lifetime gifts to your
net worth (at death) to determine whether an estate return is required. As an
easy example, say that you gift $5,400,000 over your lifetime, and you pass
away single and with a net worth of $1 million.

·If
you just looked at the $ 1 million, you would say you have no need to file.
That would be incorrect, however.

·You
have to add your lifetime gifts and your net worth at death. In this example,
that would be $6,400,000 ($5,400,000 plus $1,000,000). Your estate would have
to file a federal estate tax return.

Q: How would
the IRS know about your lifetime gifts?

A: Because
you are required to file a gift tax return if you make a gift large enough to
be considered “reportable.”

Q: What is large
enough?

A: Right
now, that would be more than $14,000 per person. If you gifted $20,000 to your best
friend, for example, you would have a reportable gift.

Q: Does that
mean I have a gift tax?

A: Nah. It
just means that you start using up some of the $5,430,000 lifetime exemption.

Q: Does that
mean that gifts under $14,000 can be ignored?

A: Not
quite. It depends on the gift.

Q: Do you
tax people take a course on hedging your answers?

A: Hey, that’s
not…, well …. yes.

Many
advisors will separate a straightforward gift (like a check for $20,000) from
something not so straightforward (like an interest in a limited partnership)
valued at $20,000.

The reason
has to do with discounts. For example, let’s say I put $2 million in a limited
partnership. I then give 100 people a 1% interest in the partnership. Would you
pay $20,000 for a 1% interest?

Let me add
one more thing: any distribution of money would require a majority vote. Therefore, if you wanted to take money out,
you would have to get the approval of enough other partners that they –
combined with your 1% - represented at least 51%.

Would you
pay $20,000 for that?

I wouldn’t. Life would be easier to simply stash the money
in a mutual fund. I could then access it without having to round up 50 other
people and obtain their vote. The only way I would even think about it would require
a discount. A big discount.

That
discount is referred to as a minority discount.

Let’s go a
different direction: what if you just sold that interest instead of rounding-up
50 other partners?

Then the
buyer would have to round-up 50 other partners. If I were the buyer, I would
not pay you full price for that thing. Again, mutual fund = easier. You are
going to have to offer a discount.

That
discount is referred to as a liquidity discount.

Normal
practice is to claim both control and liquidity discounts when gifting non-straightforward
assets such as limited partnership interests or stock in the family company.

Let’s use a
15% minority discount, a 15% liquidity discount and a gift before any discount of
$20,000. The gift after the discount would be $14,000 ($20,000 * (15% + 15%)).
No gift tax return is required unless the gift is more than $14,000, right?

Well, yes,
but consider the calculus in getting to that $14,000. If the IRS disagreed, perhaps
by arguing that the discounts should have been 10% +10%, then the gift would
have been more than $14,000 and should have been reported.

Q: This is
getting complicated. Why not skip a return altogether unless the gift is clearly
more than $14,000?

A: Why?
Because if you prepare the return correctly, there is a statute of limitations
on the gift. If you file a return and describe that gift in considerable detail,
the IRS has 3 years to audit the gift tax return. If the 3 years pass, that
gift – and that discounted value – is locked in. The IRS cannot touch it.

Do not
report the gift, or do not report it in sufficient detail, and there is NO
statute of limitations.

Q: If I am
dead, who cares?

A: Let’s return
to the estate tax return. The gift is being added-back to your estate. Without
the statute of limitations, the IRS can reopen the gift and revalue it, even if
the gift was made a decade or two earlier. That is what NO statute of limitations
means.

Q: Is this a
bogeyman story told just to frighten the children?

A: Let’s
take a look at Office of Chief Counsel Memorandum 20152201F.

NOTE: This type of document is internal to the IRS. A revenue
agent is examining a return and has a question. The question is technical
enough to make it to the National Office. An IRS attorney there responds to the
agent’s question.

The donor
(now deceased) made two gifts to his daughter. There were some problems with
the gift tax return, however:

The taxpayer did not give the legal
names of the partnerships.

The taxpayer gave an incorrect identification
number for one partnership.

The taxpayer gifted partnership interests,
requiring a valuation. The taxpayer got an appraisal on the land, but did not get
a valuation on the partnership containing the land.

Failure to get a valuation on the
partnership also meant the taxpayer failed to document any discounts claimed on
the partnership interest.

What was the
IRS conclusion?

The Service may assess gift tax
based upon those transfers at any time.”

The IRS
concluded there was no statute of limitations. No surprise there. Granted, if
there is enough money involved the estate has no choice but to pursue the
matter. It however would have been easier – and a lot cheaper - to prepare the
gift tax return correctly to start with.

Q: What is my
takeaway from all this?

A: If you
are gifting anything other than cash or publicly-traded stock, play it safe and file a gift tax return. Ignore the $14,000
limit.

About Me

Thirty years years in tax practice. It's a long time, and I have seen virtually everything short of the fabled tax-exempt unicorn. I was raised in Tampa, went to school in Missouri, taught at Eastern Kentucky University, lived in Georgia, got pulled to Cincinnati when I married, have in-laws in England and a daughter going to the University of Tennessee. I am not sure where I will wind up next, but I hope there is better weather.